The Economics of the Water Industry

In many European countries the water industry is currently undergoing significant changes that require them to address and respond to three strategically crucial issues: ownership structure, implementation of adequate incentive regulation and horizontal and vertical integration.

The water industry in Europe, with the exception of France and U.K., is largely in public ownership. This book reviews the international empirical evidence without finding support to the oft-claimed higher efficiency of private operators in the water industry. More importantly appears the introduction of adequate systems of incentive regulation.

The book examines many systems of incentive regulation focusing in particular on yardstick competition (y.c.). The best known examples of regulators adopting y.c. are Ofwat and, more recently, the Scottish Water Commissioner. There are also some elements of y.c. in the Italian “Metodo Normalizzato”. The work critically analyses the econometric models and other mathematical approaches underpinning regulation and presents some suggestions for improvement.

Econometric analysis shows that the current average size of water firms in most European countries is suboptimal. Cost saving could therefore be achieved through prudent mergers. However, M&A activity beyond a certain size appears to generate marked increases in unit costs. The analysis carried out in the book addresses the question of optimal size in the water industry and the possibility of achieving economies of vertical integration and other scope economies.